Wednesday, October 3, 2012

Unrealized Appreciation and Stock Dividends

There is no tax on the gain incurred by a taxpayer until the occurrence of a “realization event”, such as a cash dividend.  Although the cash dividend does not make the owner any richer, it serves as the trigger for taxing the enrichment that the tax system had previously ignored.

POLICY: What justifies that differing treatments of unrealized appreciation and cash dividends?   Valuation and Liquidity. In the absence of a realization event, it may be unclear how much an asset has increased in value, and in any event a mere increase in value gives the taxpayer no cash with which to pay a tax. Taxing a cash dividend, has no problems of VALUATION OR LIQUIDITY.

A pro rate stock dividend is between unrealized appreciation and a cash dividend. If appreciation in the value of stock is not taxed, then a pro rate stock dividend should also be excluded. Unrealized appreciation is not “income” within the meaning of the 16th amendment. Stock Dividends are a form of unrealized appreciation; and therefore, the attempt to tax stock dividends without apportionment was constitutionally invalid. Unless gain is clearly separated from the taxpayer’s original invested capital, as it is in the case of a cash dividend, but not in the case of a stock dividend, the gain is not income and it cannot be taxed by Congress without apportionment.

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